Coordinating economic policy

A real common economic area needs a common and coordinated economic policy built up in the European Union. The policy is to aim at guaranteeing the common currency and supporting peace and prosperity in Europe. One way to accomplish a real common economic area is the establishment of a European Economic Fund and the sanctioning of economic imbalances. This has to apply to net deficits and to net surpluses symmetrically (Horn et al. 2012 and Flassbeck 2012a). Only then, wage dumping in the Eurozone and uneven shifts in contestability can be prevented. This enables to focus on jointly increasing the productivity. Therefore, wage policies, monetary policies and fiscal policies have to be coordinated.

The economic and financial crisis in Europe shows clearly that no further steps to an intensified coordination in the economic policies of the monetary union have been taken to this day. The consequences are enormous economic imbalances in the European Monetary Union, one of the main causes of the financial and economic crisis. Approaches to solve the crisis (e.g. regulation of the financial market, redistribution of wealth and broader state financing through Eurobonds) do not alone suffice to correct the macroeconomic imbalances between the states of the monetary union. Those disparities in balances of trade and payment force enormous competitive pressure upon the states and enable the formation of dangerous bubbles as the real estate bubble in Spain. This is an inner-European problem which can only be overcome by a real common economic area with the explicit goal to compensate for the differences in balance sheets between Eurozone countries (Horn et a. 2012).

What to do?

One way to accomplish a real common economic area is to establish a European Economic Fund. That would go one step further than the present Stability and Growth Pact which has been blind for private imbalances and instead only has focused on public debts. Through the European Economic Fund, economic imbalances would be sanctioned. This would apply to net deficits and net surpluses symmetrically (Horn et al. 2012 and Flassbeck 2012a). Only then, wage dumping in the Eurozone and uneven shifts in contestability can be prevented. This enables to focus on jointly increasing the productivity. Therefore, wage policies, monetary policies and fiscal policies have to be coordinated.

Common wage policy

The problem of divergent contestability in Europe is mainly due to the differences in the increase of unit labour costs which have led to different inflation rates. Countries like Germany notably undercut the EU-wide target inflation rate of 2 % while this rate was exceeded by countries like Greece and Spain (Flassbeck 2011). To compensate for these differences, a coordinated wage policy is needed in the Eurozone, since the inflation rate is majorly determined by the wages (Flassbeck 2012a). A coordinated wage policy would lead to actual wages increasing by more than the productivity rate (because the wages in Southern Europe have already been cut short). This would help the export sectors of the southern countries and could stop the downward spiral in which the southern countries are caught, consisting of decreasing domestic demand due to wage cuts, weak exports and a rigid austerity policy (Marterbauer/Feigl 2012). Wages have to be coordinated institutionally as well as politically. A strong coordination of trade units, offensive declarations of the universality of collective agreements and a better macroeconomic coordination between Eurozone countries are urgently needed (Horn et al. 2012).

Common fiscal and monetary policy

When aiming at adjusting the target inflation rates not only on an average but on a country-by-country basis, a progressive system of taxes and fees is automatically stabilizing the inflation rate even if of minor deviations occur (Horn et al. 2012). Tax incentives are to be created in order to correct occurring deviations from the target inflation rate (e.g. profits taxes after inflation of profits). Dealing with major deviations, either expansive (if unit labour costs are increasing too little) or restrictive (if unit labour costs are increasing too much) measures of fiscal policy have to be taken (Horn et al. 2012). In countries where the public and the private sector are heavily in debt, the domestic demand would strongly decrease if the state chose a strict austerity policy. Rehabilitation of public finances can also be reached through redistributive taxation policy (Horn et al. 2012), but long-term fiscal policy is in need of further measures. Legal minimum rates for taxation of companies, income and wealth have to be defined. This would stop the competition of fiscal dumping in the EU. It has to be noted that this requires an assignment of national competences (Horn et al. 2012). The monetary policy of the ECB in the Eurozone should aim at minimizing the national deviations from the target inflation rate instead of only focusing on the average (Flassbeck 2012a). This would be made possible through a cooperation with national central banks. An option would be, for example, to adjust the minimum reserve in order to support or to curb the lending in the respective country (Horn et al. 2012).

The international imbalances are being gradually reduced since a coordinated economic policy pursues the goal of a much more consistent development of the Eurozone. Coordinated wage policies are necessary for aiming at the Eurozone-wide target inflation rate on a national level. It cannot be reached through an overall-monetary policy that does not focus on single countries. Debasement of individual currencies – which is not possible on a national basis in a currency zone – would no longer be necessary. The blind spot of the monetary union (which has been focusing on national deficits) would be illuminated. A redistribution through taxes in individual countries can also help to counteract imbalances.

Due to the new, uniform price development, countries like Germany and Austria (which are getting cheaper because of the low inflation rates) can no longer expand their exports at the expense of countries like Spain or Greece (where the inflation rate is higher than the target inflation rate). The wage competition between these states would then be repealed and a convergent development in the Eurozone would be made possible.

Due to the increased cooperation and a real monetary union, the discussed topics would not only include public external debt but also the private external debts. The imbalance of price developments in the Eurozone could be reduced. Hence, trade surpluses and deficits in the monetary union would be alleviated. The capital flow (from strongly export-oriented countries to import-dependent countries) would be curbed. The decreasing external debt leads to better ratings of government bonds. Also, it stabilizes individual national economies because, in the private sector as well, better balanced capital accounts lead to lower external debts. Therefore, market bubbles become less likely.

Rebuilding the banking system

A regulation of the banking system can contribute to re-reducing banking to its actual core: accepting deposits and lending. Various proposals, differing in their extent, have been submitted concerning the segregation of classical commercial banks and investment banks. Further possibilities are to increase the equity backing in the banking sector and to define ways that enable an organized bankruptcy of banks. An institutional innovation that is also kept in mind in this problem-solving approach is the creation of a banking union. The effects of the measures depend on their implementation. It is also about an inner stabilization of the banking system and about not letting the states pay for possibly arising bankruptcies of banks. Speculative transactions will lose their current importance when risks are limited.

Since the crisis has broken out in 2007, numerous banks had to be saved by so-called “bail-outs” using tax money. In order to restrict the impending bankruptcy of individual banks and to limit risky banking, it has to be thought about reasonable countermeasures. It has to be avoided that individual banks facing difficulties endanger the whole financial and economic system because of their size and connections with other financial institutes. In this case, the state is indeed the last safety net. Here, three steps to a reasonable reduction of banking are presented as solutions for the economic and financial crisis.

Separation of commercial and investment banks

Currently, various models concerning the separation of commercial and investment banking are being discussed. They vary in extent and conditionality of the segregation. Four of them are briefly described here to show the arc of suspense of the political discussion. The Volcker Rule, implemented in the USA, aims at a prohibition of short-term speculative proprietary trading and a restriction of risky investments, such as private equity and hedge funds (ZEW 2013). A group that has formed around the president of the Finnish National Bank has already proposed a splitting into a commercial and an investment bank in two cases. The first case would occur if the investment activities of a bank exceeded a limit of 25 % of the balance sheet totals and/or the recovery and resolution plan (RPR) which every bank has to submit were not approved by the controlling authority. The second case that requires a splitting would occur if the investment activities exceeded a limit of 100 billion euros (Liikanen et al. 2012). The proposals of the OECD go even further since they generally plan a separation in commercial and investment banks. Synergies occurring in holding structures, anyway, can continue to be used, as long as the businesses do not endanger one another. Separate equity requirements are valid (ZEW 2013). This system was long practised in the USA. The so-called Glass-Steagall-Act was a conclusion drawn from the financial crisis of 1929 but has been abolished in the 90ies in the course of market liberalization. In Germany, similar proposals are discussed, including the prohibition of especially risky proprietary trading for both types of banks as long as they are working with central bank money. Banks would also not be allowed to have business relationships with institutions which are practising such risky proprietary trading. Additionally, the Social Democratic Party (SPD) is demanding to set a limit for bonuses and other variable portions of wages of bankers and bank employees. The expansion of bubbles is thus further restricted; at the same time, the incentives for taking excessive risks in banking are being reduced. This is especially successful if a long-term approach and an increased sensitivity for risks are introduced for variable wage portions (Steinbrück 2012).

Equity backing

But even an intelligent separate banking system cannot prevent financial crises alone, and it is probable that they cannot be prevented completely (Minsky 2011). It would be a reasonable measure to strengthen the safety buffer by increasing the equity. Therefore, the bank is better protected against insolvency when assets are revaluated. Within the framework of Basel III, all European banks are obliged to hold at least 5 % of their balance sheet totals as equity. Structured financial products and short-term deals are assessed as riskier (Steinbrück 2012). Furthermore, it would be reasonable to frame the equity regulations counter-cyclically (which means to require a better equity backing in boom-phases and a lower one in recessions) in order to prevent the development of bubbles or credit crunches. It would also be useful to add limits for risk measures in lending to the equity regulations (e.g. a loan to value ratio) (Liikanen et al. 2012). Only then, the equity of a bank suffices to save it from over-indebtedness.

Bail-in instead of Bail-out

Since the banks were the ones who profited from risky business practices before the bubble burst, they should also be the ones to pay for the banks being rescued by the financial system. Only then, risk and responsibility are brought together again. A model is presented by economist Weder di Mauro, featuring three central aspects essential for a banking union: a common bank supervision; a regime for bank liquidation; and a common deposit insurance. This establishes possibilities for surveillance and liabilities on a European level (instead of, as currently, on a national level) besides the already existing European central supervision by the ECB. Hence, a collision of interests resulting from the different levels is prevented (SVR 2012).

To be an effective regulation of the European banking system, the banking union has to include all banks of the 27 member states of the EU. The accession of the banks, however, requires a qualification through the revaluation of the assets and a possibly necessary recapitalisation (Weder di Mauro 2013) as well as the compliance with Basel III (SVR 2013). The banks who have joined the banking union fund a restructuring fund, under consideration of their relevance to the system and their risks (Steinbrück 2012). The fund is available if overindebted banks have to be restructured or liquidated, thus happening according to a plan provided by the restructuring agency which is independent from the ECB (Weder di Mauro 2013 and Schneider 2013). In case of restructuration or liquidation, the interests of the creditors are subordinate to the deposits (Steinbrück 2012), which is similar to the solution practised in Iceland (Heintze 2013). Therefore, a Europe-wide homogenous deposit insurance system is necessary (Weder di Mauro 2013, SVR 2012).

The introduction of a separate banking system is protecting the deposits of savers and foregrounds the actual task of banks: the transformation of short-term deposits into long-term credits granted to private persons and companies. Depending on the degree of implementation, the aftermaths of the insolvency of individual investment banks would not be that strong, since the granting of credits as the economy’s “blood circulation” would not be stopped abruptly. Due to higher equity backing, the banking system can also deal with bigger sticker shocks, as the risks of revaluation and sudden falls in prices are opposed to bigger collaterals. This also works as a brake on the cascade in the banking system, as fewer liabilities are deducted and claims are more likely to be cleared by other banks – which leads to increased mutual trust of and in banks (Caballero/Simsek

In case of a bank failure, an independent restructuring agency takes on sale and liquidation of the concerned bank. In case of crisis, it is no longer the state who steps in but the other banks (through the rescue fund). In case of insolvency, the bank is broken up at the creditors’ expense and the parts are liquidated. This clear perspective of a sorted insolvency pushes the banks to a more cautious risk management. The creation of a restructuring fund which is run by banks unburdens the states of the costs of bank rescues and the liquidation of bad banks. In the long term, this leads to a relief of the state budgets and therefore to a bigger scope in terms of investment and financial policy. This scope can be specifically used to implement measures to increase employment and to expand educational systems.

Higher and countercyclical equity regulations help to prevent bubbles on the financial market, since especially when increasing prices are fuelling speculation, speculation gets more expensive due to higher equity requirements and therefore is limited. Additionally, the banks’ risks in lending can be limited to an amount that could, if necessary, actually be caught up by equity. New rules for managers’ bonuses and variable wage portions regulate the herd behaviour because financial market participants will rather be interested in long-term profits; short-term rent-seeking will become less attractive. Additionally, less capital is available for investment banking due to the separation of commercial and investment banking – “cheap” deposits are no longer allowed to be used as equity backing. That as well is limiting the formation of bubbles on the financial market. Another result of this brake on the speculative activities of financial market participants is that the prices obtained through forced sales are closer to the initial buying prices. Results are decreasing losses when it comes to compulsory auctions, as well as decreasing write-down losses of banks; therefore, the shock originating from the real estate market shrinks for the whole economy. These measures to regulate the banks’ deals on the financial markets are a possible step that might be taken in order to solve the crisis, but they will stay without sustainable impact if the very rules of financial markets and tax system are not changed. This change would lead to an increased economic attractiveness of real economic activities.

European Systemic Risk Board (ESRB) (2011): Recommendation of the European Systemic Risk Board of 21 September 2011 on lending in foreign currencies, Official Journal of the European Union, 2011(1), C 342/1-47.

Introducing Eurobonds

Introducing Eurobonds means that the Eurozone-states issue joint bonds for government financing. They also share the liability. There are different models which vary in extent of the joint liability and the borrowing. With the introduction of Eurobonds, the average level of interest rates decreases to the level of government bonds of European states and therefore eases the state financing. At the same time, the joint liability strenghtens the position of the states compared to the financial markets and lessens the influence that national ratings of rating agencies have on refinancing costs of the states.

The lack of trust in government bonds and the concomitant increasing interest rates lead to a massive burden of state budgets of individual Eurozone-countries. The refinancing difficulties have been intensified trough the large-scale rescues of banks. In contrast to the USA, every Eurozone country issues government bonds. This enables speculators to speculate on individual states exiting the Eurozone. The idea of an introduction of Eurobonds is based on an observation of this interrelating problems. It is the main idea behind Eurobonds that Eurozone-countries jointly take on debts on the capital markets and share the capital for which they are jointly liabile. The joint liability in the Eurozone helps to increase the stability (SVR 2011b). At the same time, the introduction of Eurobonds lowers the refinancing costs and strengthens the efforts of the states to consolidate their budgets (Depla/von Weizsäcker 2011). Various concepts of Eurobonds are being discussed. They differ in the extent of the joint liability in case of illiquidity of one Eurozone-country and the distribution mechanisms of Eurobond-capital.

Full Eurobonds

1) The complete replacement of national bond issues by Eurobonds leads to a joint liability of the entire Eurozone for the debts of all Eurozone-countries. The pressure of financial markets is thus taken from individual countries. To introduce those „full Eurobonds“, a change of European Treaties would be necessary (Steinberg/Somnitz 2013).
2) A partial replacement of national refinancing requires that bonds are separated in blue bonds and red bonds (Anleihen) vor (Delpla/von Weizsäcker 2011).All Eurozone countries are jointly liable for government debts up to 60 % of the national GDP in blue bonds which are given priority to red bonds in case of debt default. The states are liable for red bonds (which carry all government debts surpassing the limit of 60 %). The red bonds are to stay out of the banking system in order to not endanger it.
3) The reduction of government debts is the main goal of the agreement on debt repayment The parts of government debts surpassing 60 % of the national GDP are outsourced to a sinking fund. This happens under the condition of an existing clearance plan with a duration of 20 to 25 years. The states are financed by this sinking fund. As long as they stick to the clearance plan, the community is liable for the debts.
4) The aim of Eurobills is to secure the short-term borrowing and therefore to make them more independent of the capital market. A debt agency is to issue Eurozone Community bonds (term: shorter than one year). They enable short-term refinancing of the individual countries. The condition for participating in the program is strict budgetary discipline. The volume of Eurobills is limited to a maximum of 10 % of the Eurozone’s GDP (Steinberg/Somnitz 2013).

Partial Eurobonds

Partial Eurobonds prevent a joint liability of the Eurozone-countries. Instead of a joint liability, the costs of disciplined borrowing are to be lowered by the creation of European senior bonds (Steinberg & Somnitz 2013).
(1) European Safe Bonds Bonds foresee that bonds of Eurozone-countries up to a limit of 60 % of the national GDP are gradually purchased by a debt agency over a term of five years. Those bonds are divided in two tranches. The first tranche are European senior bonds, which are, in case of illiquidity, senior to the second tranche (European Junior Bonds) (Brunnermaier et al. 2011). The interest on government bonds decrease as the states themselves have less debts. Therefore, the refinancing costs are lowered as well.
(2) In the version Euro Standard Bills the bonds remain in the hands of the states but are standardized. Their issuing underlies strict conditions and regulations and is always secured by collaterals like properties or future tax revenues (EEAG 2012).

One step towards a fiscal union

All of these models of Eurobonds are just a first step for the development of the Eurozone towards a fiscal union which works as a counterpart for the stronger integration of public financing of the Eurozone. The prejudice that Eurobonds with their joint liability would pose a dangerous novelty has to be objected. The states are already indirectly liable for the government debts of other states through the contributions of their national banks to the ECB and their purchases of government bonds on the secondary market using their OMT-programs (Outright Monetary Transactions) (Steinberg/Somnitz 2013). As explained in the solution strategy „coordinated wage policy“, efforts have to be taken in the Eurozone to balance the gaps between individual Eurozone-countries in terms of competitiveness. This is the only way to avoid that Eurobonds extend the borrowing too much (Horn 2011).

The possible contribution of Eurobonds to solving the crisis strongly depends on the implemented model. The higher the extent of joint liability, the stronger the positive effects on the ratings of the bonds and therefore on public finance. Eurobonds provide, depending on the extent, a new, global and very liquid investment opportunity and could rise to be a new reserve currency. It is estimated that the interest rates would decrease by up to 0.8 %, which would lower the interest burden of Eurozone-countries by more than 100 billion euros (Cünnen, A./Mallien, J. 2011). The different debt developments of the individual states increase the security of Eurobonds and therefore lead to a lower interest rate than the arithmetical average. Also, this does not necessarily mean that Germany or Austria would have to carry higher interest burdens, since the interest on bonds which are currently issued by the Commission and the European Investment Bank are no reason to expect a rapid increase in the interest burdens (Horn 2011). This is the contribution of Eurobonds to solving the crisis: due to the decreasing refinancing costs, crisis-ridden countries are able to emerge from recession faster. The overall costs of the crisis decrease considerably (Hans-Böckler-Stiftung 2011). Furthermore, Eurobonds prevent speculation against countries (depending on the extent of joint liability). When jointly analyzing the Eurozone, the total debt is the center of attention. Macroeconomic imbalances in the Eurozone and the issue of a common fiscal policy as challenge for democratically legitimized European policy gain in importance.

The higher the joint liability due to Eurobonds, the lower the risk of credit default. This goes hand in hand with a good rating, which is an effective positive revaluation for crisis-ridden countries and therefore leads to a decreasing risk of indebtedness. Using full Eurobonds, the national ratings are at least partially replaced by an overall-rating of the Eurozone. This is a new driving force for coordinated European economic policy. It is a debatable point whether the complete changeover of public finance in the Eurozone to Eurobonds leads to the private external debt (which is often included in national ratings) no longer being discussed. In this case, it is possible that structural problems are not being reflected on. If European institutions are unable to close the developing gap, much larger bubbles would form. These bonds could only be compared to government bonds of the USA or China, for example, as they are of similar size; inner-European comparisons would become obsolete. Countries like the Netherlands or Germany would no longer indirectly profit from the crisis in southern European countries. Until now, interests on German, Austrian and Netherlandish government bonds have been decreasing, as investors have been looking for secure investment options for their money. Thanks to Eurobonds, all countries would finally have the same interest in overcoming the crisis.

Regulating financial markets

The deregulation of financial markets is a main cause of the financial and economic crisis. To solve the crisis, clear rules are necessary. Fundamental points are to reduce the complexity on financial markets and to improve the transparency of traded products and the transaction methods for all market participants as well as for the states. This necessitates to control and to prohibit financial products and business models which endanger the financial system’s stability. The goal is to curb offshore-banking and the uncontrolled growth of financial products. The financial system must be brought into service of the real economy again.

Deregulating the financial markets was a main cause of the real estate crisis in the USA, which developed to be a worldwide economic crisis. All the new, nearly completely unregulated financial products and business models have not led to efficient prices but to a giant bubble on the American real estate market which burst with a big bang in 2007.

Making Over-the-Counter transparent

Off-market over-the-counter-trades (OTC) form a major part of the transaction volume nowadays. They should be transferred to the stock exchanges (Allen/Carletti 2010). Only then, the transparency increases and the risks of the counterparty are revealed. The problem of asymmetrical information is therefore reduced (Europa AK 2010).

Regulating the shadow banking system

This transparency also has to be facilitated through a re-regulation of conduit banks in order to counteract the disguise of risks which is due to structures of special-purpose vehicles (SPVs) used by banks (SPVs are not appearing in the balance sheets) (Dietsch 2012). The same regulations (concerning equity, liquidity, risk management …) would have to be valid for those due to the fact that their business is similar to that of banks. In other words: “Same rules for same business” (Liebert et al. 2013). This means that hedge funds and private equity organizations would have to fall under the regulation of banks in the future (Liebert et al. 2013). If this is not achievable globally, pressure can be indirectly put on conduit banks by specifically taxing all deals of domestic banks (and their subsidiaries in other countries) with conduit banks or by only allowing banks to interact with financial firms which are liable to a minimum regime (Liebert et al. 2013).

Draining offshore economies

The grand success of conduit banks is mainly due to offshore economies. Therefore, regulatory intervention is needed here as well. The transparency of offshore economies has to be increased; it does not suffice to disclose balance sheets, but accounts and assets also have to be made transparent for the countries of origin (AK Wien 2013). Extensive assistance agreements, automatic reports of capital transfers, reorganization of banking secrecy, improvements of data conditions and coordination of tax policies at least in the Eurozone have to be achieved (AK Wien 2013). Furthermore, these tax and regulatory havens have to be pictorially drained; this can be achieved through taxing profits, dividends and interest which are transferred to those havens (Liebert et al. 2013).

Selecting financial products

One possibility of regulation is a retention quota of 10 %. Thus, banks have to keep 10 % of granted credits and are only allowed to securitize or sell the other 90 % to third parties (Hein et al. 2008). Such a retention quota can be defined for all purchasers of credit bundles. Vendors should then critically assess the risks of credits. Furthermore, an increasing standardization of financial products is necessary, as well as more explicit and available trade information (Hein et al. 2008, AK Europa 2010). Short sales – selling financial products one does not even own – can be prohibited. Their few positive and non-speculative functions can also be rendered by other financial products. Credit default swaps (CDS) should aim at simplifying the predictability of real economic subjects and at dealing with an uncertain future. For that to happen, CDS would have to only be traded by parties involved in the underlying transactions (AK Europa 2013).

Constant control

The European Securities and Markets Authoritiy (ESMA) should supervise the financial market more strictly in the future and particularly enforce transparency and standardization of financial products (AK Europa 2013, cf. Hein et al. 2013). A financial inspection agency should be established under the umbrella of the ESMA; it should have rights to intervene in the sector of product control and therefore be able to prohibit harmful products (AK Europa), that is to say that products are forbidden which are not useful to the real economy.

Regulating the financial markets would have the following effects: risks would not be disguised to the same extent as the have been; and the intensity of speculation dissociated from real economy would decrease. That would oppose the inflation of bubbles and limit the scale of financial crises. It would not only be much more difficult to conceal risks from the state but also from other market participants. Hence, more and better information is available to them, thus dampening the illusions of control of the market. This improves the quality of risk assessment of the market and makes some very risky financial product unprofitable.

Retention quotas help to enforce the rule that risk and liability have to go together. As risks can be directly penalized, the interest in taking advantage of asymmetrical information exchange is minimized. As a result, fewer global cascades appear. Risks tend to seemingly disappear in cascades and get visible again when bubbles are bursting. The cascading of CDOs is therefore cut back. Together with new regulations for CDS and more holistic and stricter equity regulations, the volume of traded derivatives is shrinking.

Offshore economies can no longer be used for tax evasion. Additionally, the implementation of equity regulations is enlarged and also applies to what have been blind spots on capital markets so far. The financial market’s complexity is also curbed.

The regulation of conduit banks results in offshore economies no longer being used for speculative investments which are neither subject to security regulations nor acquire an interest in public financing. In addition to that, the race between the member states (to make one’s mark as business location through deregulation) is slowed down. If there are more binding regulations on global or at least European level the states are no longer under the pressure to try catching attention with tax and regulation dumping. The regulation of conduit banks also impacts the shocks originating from individual financial institutions and change over to the whole financial system; thus, the shocks cannot grow in size. In boom periods, banks can no longer benefit from high profitability of special-purpose vehicles (SPVs) which, in case of a bursting bubble, the whole financial system and states have had to pay for so far, as the financial linkages between banks and SPVs puts pressure on the bank in case of losses of the SPV. Therefore, most bank bailouts have also been rescues of connected SPVs. Since SPVs have mainly been established to trade speculative financial products, the trade of those would also diminish. Equity backings which strengthen long-term liquidity and therefore security and mutual trust in the financial system take effect. Until now, they have mainly been a competitive disadvantage for regulated banks, as they have been affected by shocks of unregulated banks.

All in all, the increasing regulation will cause the free play of financial capitalism’s forces to retreat. Through producing uncontrolled, huge bubbles in boom periods they have diverged further and further from the real economy and developed at the expense of it. In this distance, the financial market has gained in volume. More and more untransparent OTC-deals have been made. The volatility of securities has been increased and the global risks hidden in the financial market have been enlarged. The regulation of the financial market – as it is presented here and in other chapters – leads to a declining volume of unproductive, detached financial markets. Positive effects are:
Capital is directed from zero-sum games to productive purposes
Risks are avoided
Financial innovations and trading practices occur which do not only benefit a few rich and their profits at the expense of the broad majority
Bubbles are less likely to occur

Introducing a financial transaction tax

A financial transaction tax adds a percentage surcharge to traded financial products (and works therefore like the value-added tax on real goods). Therefore, especially speculative and short-term trading in the financial market becomes unattractive. Depending on the implementation, this leads to increasing investments in the real economy and higher government revenues.

The burst of the real estate bubble in 2007 and thereby the price adjustments in the sector of mortgages and securities allow the conclusion that the paradigm of markets forming the right prices efficiently is not accurate and obviously had not applied to pricing over a longer term before the bubble burst. Before the crisis, the volume of international financial markets rapidly increased due to an enormous inflow of wealth and investment strategies in ever shorter terms. That led to an increased volatility (fluctuation) of prices on the financial markets and therefore considerably destabilized the financial market (Schäfer 2013). In order to stabilize the financial market, it has to be decelerated and downsized to a healthy size which does not endanger the real economy (Schulmeister 2013). This is exactly what can be achieved through a FTT, for it makes risky and short-term oriented trading unattractive, redirects investments of capital in the real economy and strengthens the revenue base of states.

A financial transaction tax adds a percentage surcharge to traded financial products (and therefore works like the value-added tax on real goods). Any such tax should be extended to all categories of assets in order to guarantee the stabilizing effect in full extent and make it impossible for financial players to circumvent the regulations (Schäfer 2013).
As it is a very improbable option to globally introduce the FTT in one step, it makes sense to start with those countries which are ready for it. The more countries involved, the bigger the impact of the tax. Because of the home state principle its impact is also highest there (Schäfer 2013). Every transaction carried out by a European financial institution would be taxed. Highly speculative asset classes (forward transactions) should be debited, others should have their tax burdens reduced; therefore, most models include a scaling ranging from 0.01% to 0.1% for different asset classes as well as a capture of unregulated OTC-trades (deals which are not made at the stock exchanges) (Schulmeister 2009, Fricke 2011). 11 EU states already chose to introduce a FTT, a step which is supported by the European Parliament (Deutsche Welle 2013).

A financial transaction tax leads to speculation (extremely short-term oriented and purely fiscal investment of capital) being less attractive. Especially short-term oriented investments with rather small profit margins are made less attractive by the FTT (Fricke 2011). The long-term speculation in shares which does not change with every passing minute would be hardly debited compared to short-term trades with high capital investment. Therefore, short-term as well as long-term price fluctuations (volatilities) are made smaller (Schulmeister 2009). Furthermore, a financial transaction tax curbs use and nesting of new financial products (e.g. loans which are securitized multiple times) and thus can contribute to the avoidance of bubbles on the financial market (Schäfer 2012). Besides, the high frequency trading operating in milliseconds is curbed; high frequency trading potentiates the effect of boosts in the stock and therefore adds to the instability of the financial market (Schulmeister 2009, Schäfer 2013).

At least rudimentarily, the unequal taxation of labour and capital (which negatively impacts real economy investments) is being fought (Schulmeister 2009) and therefore the investment of capital is directed towards the real economy again.

A financial transaction tax also stops the trend of companies placing their profits on the financial markets without investing it, for, due to the financial transaction tax the returns on the financial market would decrease. Due to the increasing investments, consumption will increase, as the state has more money at its disposal. Hence, unemployment and other macroeconomic problems can be combated (Schulmeister 2013).

Depending on the extent (0.01%, 0.05% or 0.1%) the financial transaction tax leads to significant additional tax revenues. The amount of revenues strongly depends on how strongly the volume of transactions will decrease due to the FTT. Schulmeister estimates the additional revenues of EU states (at a rate of 0.05% up to 0.1 %) to be tens of billions of euros (2009). Therefore, the financial market shares in the costs which arise from the financial and economic crisis. This facilitates the refinancing of the states.

GEnforcing fair distribution

Over the last years, the tax burden on income, wealth and profits have diminished as a result of the global tax competition. At the same time, income and wealth have diverged ever further and have been used for speculative purposes.

The related slump in real economy caused many employees to get into debt as this was the only way to maintain their life standards. All of this led to the real estate crisis in the USA and to the crisis in the Eurozone. A stronger redistribution will redirect useless capital from the financial capitalism to the real economy. It is therefore possible to finance public goods and services, such as education, health services or a traffic system and let the employees share in the added value they ultimately produce. The concentration of wealth in the hands of a few is opposed, thus having many social advantages. As Wilkinson and Picket point out in their work “The spirit level” (2009), many social problems – as, for example, obesity, criminality and mental illnesses – are connected with the inequality of a society.

Minimum taxes

It is necessary to introduce minimum taxes and maximum tax allowances for profits taxes, inheritance taxes and wealth taxes. It has to be the goal to curb European tax competition and to create clear perspectives for entrepreneurs (Schratzenstaller 2011).

Taxing companies

In the field of company taxation, the tax avoidance of big, multinational companies has to be curbed. Those benefit from internationally shifting profits (what smaller businesses cannot do). The German state alone is deprived of taxing companies’ profits in the amount of approximately 100 billion euros (Rixen and Uhl 2011). Measures against tax avoidance can be: introduction and strict control of transfer prices in multinational companies; curbing of European and global tax competition; and a European coordination of company taxation in Europe (Rixen/Uhl 2011). It could be a perspective to extend the group tax regime based on the Austrian model to Europe; this step should make tax avoidance impossible (Saringer 2013).

Taxing high incomes and wealth

There are further steps necessary in the field of individual taxation as well. Taxing great wealth could be a step towards a fairer distribution. The sales value of the assets would have to be the basis of taxation (Jarass/Obermair 2011). An additional, onetime levy on wealth can help to moderate the wealth inequality that has increased over the last years and therefore moderate the social consequences of inequality. Higher inheritance taxes bring the handover of wealth between generations in the service of the common welfare. At the same time, it makes it harder to accumulate very high wealth. In the field of income taxes, a higher maximum tax rate can be introduced. This will majorly affect those incomes of which only a little part is used for consumption. At the same time, the revenues (which increase due to this measures) can be used to take the load off lower incomes (which are mainly used for consumption) by lowering the tax rates and increasing the allowances. This would have a positive impact on consumption and therefore at the economy (Bach/Haan 2011).

Taking back false tax incentives

Curbing private indebtedness in the corporate sector is another measure, since a high degree of debt capital has destabilizing effects on markets and therefore should be limited by abolishing the fiscal advantages of indebtedness (Allen/Carletti 2010).

When increasing the taxes on wealth, inheritances and profits (which are not due to work), the overall volume of speculation on financial markets is reduced. The inequality between taxation of capital and labour is evened and the available income of poorer households can increase again. The redistribution of low wage incomes to capital incomes is also curbed by the real economic area which intends wage trends to be oriented by productivity trends and the target inflation. The inequality in taxing small and middle-sized businesses compared to big multinational companies can be balanced by the proposed rules. Hence, small and middle-sized companies are no longer disadvantaged in the future.

A greater redistribution also results in increased domestic demand, as redistributive tax policies favour incomes with a high consumption quota and a little tendency towards saving. This leads to an increasing demand. Higher tax revenues would also give the state more possibilities for public investments.
Stimulating consumption also leads to a decreasing export surplus due to additional imports in countries like Austria and Germany. Therefore, trade imbalances would be reduced. More balanced trading relationships would also moderate the economic differences in the EU, another contribution to solving the crisis.

In order to finance the life standard and keep it constant, private households have run into debts in the last years – especially in the USA. This development can be stopped by increasing wage shares and greater redistribution. The indebtedness of companies as well is limited by the removal of tax incentives for raising external capital. The quality of granted credits will improve; fewer toxic debts will be granted. Thanks to an increased taxation of wealth (by its sales value) price bubbles are curbed. The dependency of the financial market is lowered and the economy is stabilized.

Due to the decreasing consumption in many countries, private investments have also decreased there, as the domestic demand is an important driving force for companies’ investments. Therefore, strengthened private and public consumption would lead to additional investments. At the same time, investing capital on the financial market would cease to be attractive for companies because of higher taxation of wealth and finance profits. Instead, investing in real-economy-projects would become more attractive. This tendency is reinforced by curbing the outside capitalization, what can also lead to increased investments.

Curbing the tax competition could combat the “level effect” (Schratzenstaller 2011). This means the mutual undercutting in taxing by states in the hope of attracting companies. In the short term, this is indeed strengthening the competitiveness of individual countries, but it is at the expense of other countries. Ending this competition leads to transnationally increasing tax revenues in the medium- and long term. A greater redistribution of high wealth and income to broad levels of the population also leads to an increasing domestic demand and thus to positive effects on employment. This would steady the expenditure side of a state, since automatic stabilizers as, for example, unemployment insurance, would no longer be used that intensively and furthermore, tax revenues would increase due to additional wage taxes. Strengthening the revenue side of states facilitates the consolidation of public budgets and leads to decreasing interest costs as the received ratings get better. Redistribution thus opens the possibility of investing in future-oriented projects.

Implementing the competitiveness pact

The „sixpack“ includes new statutory regulations concerning the question of how to deal with macroeconomic imbalances in the European Union in the future. The main concern is approximating the competitiveness of member states. The competitveness of the EU as a whole should be improved.

To prevent future irritations deriving from long lasting macroeconomic imbalances, it is tried to record those imbalances by using early warning indicators. Ten indicators are merged in a scoreboard. They can be summarized in the following generic terms: “extern imbalances and competitiveness” (indicators as current account balance, nominal unit labour costs) and “intern imbalances” (indicators as debt level of the private sector, public debt) (Essl/Stiglbauer 2011). They are supplied with certain thresholds in the scoreboard. In case of exceedance or lower deviation, the European Commission is obliged to further investigate the imbalances of concerned countries. These investigations result – in coordination with the European Council – in recommendation of preventive measures to the states. In case of very strong deviation, corrections are suggested to and negotiated and scheduled with the states. Deviations of such plans are sanctioned by the European Commission (with a limited say of the European Council); these sanctions occur as fiscal sanctions in the amount of one hundredth of the GDP (Essl/Stiglbauer 2011). The procedure of correcting the imbalances does not end until it is proposed to the European Council by the European Commission and the Council accepts this proposal.

The new competitiveness pact with its ten given indicators induces a stronger integration of economic policy. But this integration is only a seemingly one, as the pact’s logic consists of the idea of all nations improving their competitiveness individually. Since competitiveness is a relative term (Flassbeck 2012), it must be feared that the implementation of the competitiveness pact leads to a new undercutting-type of competition between the states (Feigl/Zuckerstätter 2012). It is unrealistic to expect that new rivalry for competitiveness eliminates the macroeconomic imbalances in the Eurozone. The competitiveness pact cannot compensate for the imbalances in the Eurozone, as its thresholds for national permissible current account balances are asymmetrical. That means that a positive balance is allowed up to a maximum of 6% whereas a negative balance is only allowed down to -4% (Essl/Stiglbauer 2011). Since most of trading of Eurozone-countries happens in Europe, such an asymmetry of objectives remains a risk for trade imbalances. Furthermore, conflicts of objectives are to expect. If, for example, it is tried to balance a state’s current account balance by all available means, this can result in rising unemployment. Therefore, the threshold could be exceeded and the measures could lead to a larger public debt. In addition, combatting the current account balance or high indebtedness of the private sector does not achieve its objective if the most important trade partners do not adapt themselves. Only a holistic coordination could prevent individual vicious circles of trying to be individually competitive and include the right impulses for a joint development of productivity. Success of exports is not only based on low prices due to low wage costs as they only have a small impact on prices. It is also based on growing sales markets and a favourable development of demand for the mainly exported products (Feigl/Zuckerstätter 2012). All of these aspects are ignored by the regulations.

The new rules on competition show a strong preponderance of exports opposed to imports and generally consider exports as more productive. But the fact is neglected that, on the one hand, not all countries in the world can have export surpluses and, on the other hand, especially the domestic demand is essential for the overall demand for a country’s products (Feigl/Zuckerstätter 2012). The development of decreasing wage shares in many countries is not visible on the scorecard, but it is an obvious sign for the main reason of exports stagnating on a low level: increasing profit margins. Many countries face profit inflations instead of wage inflations. By that is meant that prices do not increase due to higher wage costs but due to higher profits for shareholders (Feigl/Zuckerstätter 2012). The unit labour costs are only analysed nominally in the new competitiveness pact. But if they are not adjusted for inflation (Essl/Stiglbauer 2012), it can lead – again – to differing developments in terms of competitiveness. The causes of the current crisis would therefore be reproduced. Furthermore, the threshold values set forth for the development of unit labour costs are +9%/-9% (which is very high); therefore, no connection to the target inflation rate can be perceived, even though Eurozone-countries should orientate themselves towards this rate in order to compensate for dangerous imbalances (Flassbeck 2012). The development of income and wealth distribution is not shown as well, even though those aspects are crucial for the domestic demand and thus for the balance between import and export. Since the competitiveness pact does not require a stable development of wages, the domestic demand will be limp in future and therefore, the door to a growth-protecting consolidation of public budgets will be closed.

When investigating the trade imbalances, it soon becomes obvious that the current account surplus of one national economy is the current account deficit of another one. Catalogues of measures which stop at national borders – as demanded in the six-pack – therefore stay ineffective. The European Commission wants to solve these issues by letting states undercut each other and therefore shrink (Schulmeister 2012). The risks of not ending this austerity competition and of unilateral wage restraints only changing the nationality of problematic unemployment in the EU are misjudged. The endpoint will not be reached before the wages in Eurozone countries have completely collapsed and the social standards are limited to an absolute minimum. The potential of national economies degenerates rapidly. Since countries like Germany are only investigated by the European Commission if their current account surplus surpasses 6% due to the asymmetrical thresholds, the trade imbalances between those countries and peripheral countries will last for much more time to come, as peripheral countries have to orientate their current account deficit by the threshold of -4%. The gap remains large and unequally distributed. The focus on the indicator export-quota (and the mere analysis of the question if it has decreased by more than 6% over the last 5 years (Essl/Stiglbauer 2012)) overestimates the positive effects of exports. More important than the export rate is the part of the added value of exported products that has been created within the domestic territory. Only this figure would reveal something about the inland production. Anyway, this is not included in the usual figures. The relevance of exports into third countries is clearly overestimated. This shows in policies of supporting export shares by wage restraint and – with few exceptions – has led to collapsing consumption and employment over the last years (Feigl/Zuckerstätter 2012).

The new competitiveness pact makes it possible to include the private debts (besides the public debts) in the analysis. Essl/Stiglbauer (2013) show that the huge bubbles in Spain and Ireland would have become visible if the indicators of the scoreboards had been used. However, the competitiveness pact has no intention to implement measures even in this case. A further ongoing build-up of foreign debt would still be possible, since the thresholds of -4%/+6% leave sufficient space open for current account surpluses or deficits. Those are reflected in ever-increasing foreign debts and capital exports and will build up enormous imbalances over the years. The huge account balances still allow developments of unit labour costs (whose thresholds are very high) which are not linked to the inflation trend and therefore do not limit the surplus exports of countries like Germany at the expense of other small countries. Hence, the inflation trend is still not controlled at an EU-level (Flassbeck 2012). The central bank policy is kept away from the economic coordination of the Eurozone, thus building a new fundament for future imbalances and disagreements.

Extending the European Stability Mechanism

The European Stability Mechanism was introduced in 2012 as a recipe for combatting the crisis. The purpose of the ESM is to financially support illiquid member states of the Eurozone. The most important instruments of the ESM are emergency credits and bond purchases. Condition for receiving financial support from the ESM is a macroeconomic adjustment programme monitored by the troika of ECB, IMF and the European Commission.

The ESM is a permanent crisis management mechanism. It was introduced in the middle of 2012 and includes 700 billion euros. It replaces the EFSF which was implemented in 2010 as a reaction to the sovereign debt crisis. The aim is to support Eurozone-countries whose financial stability is massively endangered (ESM 2012). This case occurs if interests on government bonds are too high, thus making it impossible for the state to finance itself in the long term. To ensure that not the whole monetary union is endangered in such a situation, the ESM buys governmental bonds of crisis-ridden countries and makes credit lines available in order to reduce the interest level for refinancing to an affordable level (Busch 2012). Due to the long-term establishment of the ESM and specific purchasing programs for governmental bonds, the EU is already a liability union (Schwall-Düren 2011), as the ESM is primarily financed by contributions of the Eurozone-countries. The amount of contribution depends on the size of the ECB-deposits and are levered by the issuing of bonds through the ESM (ESM 2012). The member states therefore only grant guarantees which make it possible for the ESM to raise money on the international financial markets (which is then borrowed to crisis-ridden countries under favourable conditions).

Using the ESM (previously: the EFSF) for government financing is only possible if in parallel, macroeconomic adjustment programs are executed. Those have to be coordinated with and controlled by the troika consisting of members of the IMF, the ECB and the European Commission. A drastic austerity policy is then implemented. It aims at reducing the deficit mainly by cuts in expenditures. As Greece and Spain show, this strategy leads to a massive economic slump and high unemployment rates.

It is exactly this logic of downsizing the state, low indebtedness and a seemingly increased competitiveness due to low wages that will, besides the ESM, obtain the status of international law through the fiscal pact and the competitiveness pact. The economic effects can therefore also be found in the chapters “fiscal pact” and “competitiveness pact”.

The ESM’s immediate goal is to avoid the failure of individual Eurozone-countries by reducing the interest burden and therefore making it easier for countries to consolidate their budgets. But this possibility is lost by using the assigned ESM-money for structural reforms at the same time which negatively impact the GDP and worsen the revenue situation of states. A consolidation of national budgets becomes therefore impossible. In the long term, the GDP will decrease because of high unemployment (Flassbeck 2013). Regarding Greece, the imposed austerity plans started at the beginning of 2010; at the beginning of 2011, Portugal and Ireland followed Greece under the umbrella of EFSF and, later, ESM. Newest figures of Eurostat (2013b) show that the debt ratio has increased by 3.6 % (Greece), 3.5 % (Portugal) or 7.7 % (Ireland) in the fourth quarter of 2012. The austerity packages do not fulfil their actual purpose, due to their destructive effects on the GDP. The ESM’s volume will not suffice in case of an acute crisis of Greece or Spain, why, according to Busch (2012) the volume should surpass a billion euros in order to curb speculation against the performance of the ESM and the Eurozone-countries. Until now, the ESM does not have interest target values (in terms of automatically supporting the refinancing of states if their financing surpasses a specified interest rate). If there were such an interest target value, the ESM had to be provided with a banking license. Then, it could finance itself directly through the ECB and therefore certainly achieve the target value (DGB 2012).

From the very beginning, the ESM also has been a saving instrument for banks which have become risk carriers in the course of the crisis and therefore are endangering the entire real economy. This indirect bank rescue has been handled by the states; the money they received was, among other things, used for recapitalizing banks. A new regulation of the Euro-ministers will make it possible for banks to recapitalize directly through the ESM after close examinations (Mussler 2013). This poses a direct liability of the Eurozone-countries for individual banks which are on the brink of insolvency. Hence, the financial system can be directly stabilized without overburdening the banks’ countries of origin with new costs. But this mechanism (which is also seen as the first step towards a banking union) has two effects which have to be considered: firstly, it is a direct signal effect for banks that, in the end, it is the taxpayers who are liable for toxic debt and speculative deals; and secondly, in case of bank failures, Eurozone-countries will be confronted with high costs; therefore, borrowing and interest burdens are going to increase again rapidly.

The states have to make savings

So far, solution strategies have focused on strict austerity policies. Now, a reformation of the Stability and Growth Pact lies ahead (the “sixpack”, a six-stage legislative procedure). It establishes a new competition and fiscal pact.

The austerity policy in Europe is mainly supplied by the image of a Swabian housewife who, when short of cash, tightens her belt to pay off her debts (Flassbeck 2012). The austerity policy in Europe is mainly determined by the troika consisting of IMF, ECB and the European Commission. The troika decides whether the countries have implemented the saving programs and whether they will receive further money out of the rescue fund. The allocation of money to those countries is linked to strict economic conditions which press the countries into the logic of Swabian housewifes.

Based on this logic, a European fiscal pact is being implemented. It aims at curbing public debts and therefore at indirectly stabilizing the financial market (Schrooten 2012). The fiscal pact aims at the submission of government budgets to a debt ceiling of 60% which, if surpassed, has to be satisfied again within 20 years. In addition to this limit, there is also a deficit ceiling which allows for a structural deficit at a maximum of 0.5 % of the GDP (Schrooten 2012). The implementation of the fiscal pact is triggered automatically and therefore allows for no exceptions for different causes of indebtedness (IMK 2012). To detect transgressions of the deficit ceiling, economists determine the structural deficit and, for this purpose, estimate the output gap (the gap between the potential and current production of a national economy (Schulmeister 2012)). This is of great importance for the fiscal policy of concerned countries. The higher the structural deficit is claimed to be (and therefore, the lower the part of the deficit is that is said to be due to the current economic situation), the more savings have to be made. It is these procedures of estimation that leave a huge leeway, as shown in the fact that estimations of structural deficits vary depending on the institution (Schulmeister 2012 and Schrooten 2012). Leaving the path towards consolidation which leads to a debt-to-GDP-ratio of 60 % in order to combat economic downswings effectively with economic policy depends on the approval of economists of the European Commission (Schulmeister 2012). The compliance with regulations of the fiscal pact is examined by the European Court (IMK 2012).

The austerity policy has led to a dramatic slump in the GDP of European peripheral countries. This is mainly due to the fiscal multiplier. The fiscal multiplier gives information about the consequences of a decrease in public spending on the GDP. A fiscal multiplier of 1.0 therefore would mean that a 1 % decrease in public spending leads to a 1 % decrease of the GDP. This fiscal multiplier (which, before the crises, was predicted to be 0.5 %) was corrected to 0.9-1.7 % by the IMF in 2012, which is notable as it empirically proves the harmful effects of austerity policy (IMF 2012). Such a policy is able to reduce the budget deficit of the states but also leads to a disproportional slump of the GDP and to an increasing debt ratio instead of a decreasing one. This is where the comparison to Swabian housewifes is not adequate, for a Swabian housewife can count on a stable income. The more a state tightens its belt even though the fiscal multiplier is high, the more it strangulates itself as its revenues decrease with the tightening. It is exactly this damaging understanding of public finance that excludes the important interactions of sectors (Schulmeister 2013). As stated above, the effect of the fiscal multiplier points out the weaknesses of this logic. In times of crises, the private sector cannot compensate for the state’s hasty withdrawal. The austerity measures therefore do not contribute to combatting indebtedness but are even worsening the situation (Schulmeister 2012, cf. Frankel 2013). This is ignored by the fiscal pact. Economists as Tober (2012) and Schulmeister (2012) already forecast a new vicious cycle. States are obliged to strict saving because of the deficit criterion. This leads to a decreasing GDP, which, again, leads to an increasing debt ratio. Therefore, long-term debt reduction – the mentioned 20 years are binding – is getting harder, resulting in a downward trend of reductions in expenditure. Because of the fiscal pact, the entire EU – and therefore also countries as Germany, which can refinance as cheaply as seldom before due to its debt quota of 80% – has to make savings (Schulmeister 2012).

The exclusive focus on public debt of European crisis management remains the same and does not change due to the fiscal pact (Tober 2012). The private indebtedness stays in its minor position and is analysed separately. Spain and Ireland would have satisfied the fiscal pact until 2007. Hence, the risks of their national economies (which have not been hidden in the public sector) would not have been noticed even with the new regulations. But it is those risks of the private sector which are integrated in the ratings of rating agencies when they estimate the creditworthiness of different countries. Therefore, stricter budgetary discipline does not necessarily cause better ratings if the private sector is developing in the opposite direction. If the ratings actually improved and the European debt levels decreased, a stabilization of the financial market still could not be assumed. Due to the redundant liquidity, the risk surcharges on bonds of other countries and companies would decrease. Therefore, new bubbles could form elsewhere and much more easily, and they would, in the end, find their way to Europe thanks to the global connections (Schrooten 2012). Although the private indebtedness is observed in the scorecard of the new competitiveness pact, this does not suffice as it is examined separately instead of together with public debts. But public and private debts have to be investigated together, as they are strongly interdependent. States can only become more solvent if they succeed in reducing private and public debt.

The targets set by the fiscal pact will most probably mainly be achieved by structural expenditure cuts, since tax increases are less attractive (Schrooten 2012, cf. Schulmeister 2012). This one-sided consolidation leads to a damping of the economic growth and decreasing state revenues from wage and profits taxes. By implementing the fiscal pact, this austerity policy becomes obligatory for the entire Eurozone, thus reinforcing these dynamics, as the saving of one country is not compensated for by investments or consumptions in other countries. Due to these negative effects on the economy, the interest rates on government bonds could even increase instead of – as it is hoped for – decrease.

Austerity policy which consists mainly of cutting government expenditures does not counteract the tendency of the last years. A majority of private investors prefers investing on financial markets instead of the real economy, the reason for the decreasing volume of investments in Europe. Politics is even speeding up this tendency, as cutting government expenditures inevitably results in declining public investments in fields like education or infrastructure. This leads to lower consumption and lower investments in the real economy (Flassbeck 2012).

In case of weak domestic demand, the strategy of countries like Germany has usually been to compensate for it by exports, thus building up trade imbalances between Germany and other countries. This will probably get more difficult due to the fiscal pact, as it leads to damped domestic demand in each Eurozone-country (Schulmeister 2013). This poses a problem, especially for export-oriented countries. Because of austerity measures (which mean a reduction of the welfare state) (Schulmeister 2013), recipients of low wages will have to do without parts of their incomes as they are provided by the state thanks to social insurances. This will additionally weaken the domestic demand, as the lower income brackets spend most of their incomes and have very low saving quotas (unlike the upper income brackets).
The fiscal pact connects anticyclical (that means, contrary to the economic cycle) economic policy and huge preconditions – making it ineffective in terms of time (Schulmeister 2013, cf. IMK 2013) – but pro-cyclically (parallel to economic developments) forces the states to make savings. In the course of decreasing GDPs, the potential output is quickly revised downwards, causing the structural share of the states’ budget deficit to rise (Tober 2013, cf. Schulmeister 2012). The pressure to make savings could even curb the application of automatic stabilizers as unemployment benefit or similar measures; therefore, in case of economic changes, it could even prevent a stabilization of domestic demand (Tober 2012). Because of these functions, the fiscal pact can become a brake on growth (Schrooten 2012).

The effect of government expenditures is, above all, a redistribution of income from higher incomes to lower incomes. This redistributive function is strongly limited by austerity policy. This is not only problematic for reasons of justness. The redistribution has been strengthening the domestic demand by redistributing parts of the incomes of recipients of high incomes (who therefore have high saving quotas) to recipients of small incomes (with low saving quotas). This happened, for example, through the social insurance systems. Since expenditure cuttings will mainly negatively affect the welfare state (Schulmeister 2012), recipients of social insurance services and civil servants will have to face income losses. As this mostly affects recipients of small incomes, the private indebtedness is further increasing. The private indebtedness has already increased strongly over the last years, since the private households have tried to keep their life standard constant while continuingly facing income losses. In order to do this, they had to accumulate debt. The probability of dangerous bubbles rises due to this increasing indebtedness of private households. Furthermore, public expenditures in form of public investments can have a positive and long-lasting effect on welfare (Schrooten 2012). Financing through debt can therefore be legitimate. Investments in education, science and transport infrastructure are, on the one hand, creating increased domestic demand in the short term and, on the other hand, support the potential of the national economy, stimulate private investments (Miller/Skidelsky 2013) and lead to a more equal distribution.